9 Factors Influencing Pricing Decisions of a Company
Some
of the major factors influencing pricing decisions of a company are as follows:
A company’s price level sends signals
about the quality of its products to the customer. A customer always compares
the company’s prices with those of its competitors. The competitors also keep
an eye on the price levels of a company.
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Very low prices may invite price wars,
while high prices without sufficient ad ditional features or quality invite bad
publicity. Distribution channel members also exert pressure on prices by
demanding higher margins.
1.
Price-quality relationship:
Customers use price as an indicator of
quality, particularly for products where objective measurement of quality is
not possible, such as drinks and perfumes. Price strongly influences quality
perceptions of such products.
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If a product is priced hig her, the
instinctive judgment of the customer is that the quality of the product must be
higher, unless he can objectively justify otherwise.
2.
Product line pricing:
A company extends its product line
rather than reduce price of its existing brand, when a competitor launches a
low price brand that threatens to eat into its market share. It l aunches a low
price fighter brand to compete with low price competitor bran ds.
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The company is able to protect the image
of its premium brand, which continues to be sold at a higher price. At a later
stage, it produces a range of brands at different price points, which serve
segments of varying price sensitivities.
And when a customer shows the
inclination to trade up, it persuades him to buy one of its own premium brands.
Similarly, if a customer of one of its premium brands wants to trade down, it
encourages him to buy one of its value brands.
But, it is not easy to maintain a
portfolio of brands in the same product category. The company needs to endow
each of its brands with an independent personality, and identify it with a
segment.
A company’s brands should not be
floating around, willing to grab any customer that t hey can, but they should be
specifically targeted at segments—customers of the target segment should like
the brand, but customers of other segments should not like it enough to buy it.
3.
Explicability:
The company should be able to justify
the price it is charging, es pecially if it is on the higher side. Consumer
product companies have to send cues to the customers about the high quality and
the superiority of the product.
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A su perior finish, fine aesthetics or
superior packaging can give positive cues to the customers when they cannot
objectively measure the quality of the offering. A company should be aware of
the features of the product that the customers can objectively evaluate and
should ensure superior performance of those features.
In industrial markets, the capability of
salespeople to explain a high price to customers may allow them to charge
higher prices. Where customers demand economic justifications of prices, the
inability to produce cost arguments may mean that high price cannot be charged.
A customer may reject a price that does
not see m to reflect the cost of producing the product. Sometimes it may have to
be explained that premium price was needed to cover R&D expenditure, the
benefits of which the customer is going to enjoy.
4.
Competition:
A company should be able to anticipate
reactions of competitors to its pricing policies and moves. Competitors can
negat e the advantages that a company might be hoping to make with its pricing
policies. A company reduces its price to gain market share.
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One or more competitors can decide to
match the cut, thwarting the ambitions of the company to gamer market share.
But all competitors are not same and their approaches and reac tions to pricing
moves of the company are different.
The company has to take care while
defining competition. The first level of competitors offers technically similar
products. There is direct competition between brands which define their
businesses and customers in similar way.
Reactions of such competitors are very swift
and the company will have to st udy each of its major competitors and find out
their business objectives and cash positions.
Competitors who have similar ambitions
to increase their market share and have deep pockets will swiftly reduce price
if any one of them reduces prices. A telephone company offering landline
services has all telephone companies offering landline services as its first
level of competitors.
The second level of competition is
dissimilar products serving the same need in a similar way. Such competitors’
initial belief is that they are not being affected by the pricing moves of the
company.
But once it sinks in that they are being
affected adversely by t he pricing moves of a company that seemingly belongs to
another industry, they will take swift retaliatory actions. The telephone
company has the mobile phone operators as its second level of competitors.
The third level of competition would
come from products serving the problem in a dissimilar way. Again such
competitors do not believe that they will be affected. But once convinced th at
they are being affected adversely, swift retaliation should be expected.
The retaliation of third level is
difficult to comprehend as their business premises and cost structures ar e very
different from the company in question. Companies offering e-mail service are
competitors at the third level of the telephone company. A company must take
into account all three levels of competition.
5.
Negotiating margins:
A customer may expect its supplier to reduce
price, and in such situations the price that the customer pays is different
from t he list price. Such discounts are pervasive in business markets, and take
the form of order-size discounts, competitive discounts, fast payment
discounts, annual volume bonus and promotions allowance.
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Negotia ting margins should be built,
which allow price to fall from list price levels but still permit profitable
transactions. It is important that the company anticipates the discounts that
it will have to grant to gain and retain business and adjust its list price
accordingly. If the company does not build potential discounts into its list
price, the discounts will have to come from the company’s profits.
6.
Effect on distributors and retailers:
When products are sold through
intermediaries like retailers, the list price to customers must reflect the
margins required by them Sometimes list prices will be high because middlemen
want higher margins.
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But some retailers can affo rd to sell
below the list price to customers. They run low-cost operations and can manage
with lower margins. They pass on some part of their own margins to customers.
7.
Political factors:
Where price is out of line with
manufacturing costs, political pressure may act to force down prices.
Exploitation of a monopoly position may bring short term profits but incurs
backlash of a public enquiry into pricing policies. It may also invite customer
wrath and cause switching upon the introduction of suitable alternatives.
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8.
Earning very high profits:
It is never wise to earn extraordinarily
profits, even if current circumstances allow the company to charge high prices.
The pioneer companies are able to charge high prices, due to lack of
alternatives a vailable to the customers.
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The company’s hig h profits lure
competitors who are enticed by the possibility of making profits. The entry of
competitors in ho rdes puts tremendous pressure on price and the pioneer company
is forced to reduce its price. But if the pioneer had been satisfied with
lesser profits, the competitors would have kept away for a longer time, and it
would have got sufficient time to consolidate its position.
9.
Charging very low prices:
It may not help a company’s cause if it
charges low prices when its major competitors are charging much higher prices. Customers
come to believe that adequate quality can be provided only at the prices being
charged by the major companies.
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If a company introduces very low prices,
customers suspect its quality and do no t buy the product in spite of the low
price. If the cost structure of the company allows, it should stay in business
at the low price. Slowly, as some customers buy the product, they spread the
news of its adequate quality
.
The cu
stomers’ belief about the
quality-price equation starts changing. They start believing that adequate
q uality c an be provided at lower prices. The companies which have been charging
higher prices come under fire from customers. They either have to reduce their
prices or quit.
